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    Cost Behavior: Analysis and USE: Patrick Louie E. Reyes, CTT, Micb, Rca, Cpa

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    Claudette Clemente
    Costs can behave in three ways: variable, fixed, or mixed. Variable costs change proportionately with activity level, while fixed costs remain constant regardless of activity level. Mixed costs have both fixed and variable components. The high-low method and least-squares regression method can be used to separate the fixed and variable portions of mixed costs. Both methods derive equations that represent the relationship between total costs and activity level based on data points provided. Understanding how costs behave is important for planning, control, and cost analysis.

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    Cost Behavior: Analysis and USE: Patrick Louie E. Reyes, CTT, Micb, Rca, Cpa

    Uploaded by

    Claudette Clemente
    46 views24 pages
    Costs can behave in three ways: variable, fixed, or mixed. Variable costs change proportionately with activity level, while fixed costs remain constant regardless of activity level. Mixed costs have both fixed and variable components. The high-low method and least-squares regression method can be used to separate the fixed and variable portions of mixed costs. Both methods derive equations that represent the relationship between total costs and activity level based on data points provided. Understanding how costs behave is important for planning, control, and cost analysis.

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    Lesson_3_-_Cost_Behavior_-_Analysis_and_Use

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    Costs can behave in three ways: variable, fixed, or mixed. Variable costs change proportionately with activity level, while fixed costs remain constant regardless of activity level. Mixed costs have both fixed and variable components. The high-low method and least-squares regression method can be used to separate the fixed and variable portions of mixed costs. Both methods derive equations that represent the relationship between total costs and activity level based on data points provided. Understanding how costs behave is important for planning, control, and cost analysis.

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    46 views24 pages

    Cost Behavior: Analysis and USE: Patrick Louie E. Reyes, CTT, Micb, Rca, Cpa

    Uploaded by

    Claudette Clemente
    Costs can behave in three ways: variable, fixed, or mixed. Variable costs change proportionately with activity level, while fixed costs remain constant regardless of activity level. Mixed costs have both fixed and variable components. The high-low method and least-squares regression method can be used to separate the fixed and variable portions of mixed costs. Both methods derive equations that represent the relationship between total costs and activity level based on data points provided. Understanding how costs behave is important for planning, control, and cost analysis.

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    COST BEHAVIOR:

    ANALYSIS AND
    USE
    PATRICK LOUIE E. REYES,
    CTT, MICB, RCA, CPA
    Do Costs React? 😱
    Yes, they do! And they react scientifically, which is good
    news for you. It will be easy to predict how a cost will
    react based on changes on different factors within the
    relevant range. 😉

    This reaction to changes is called Cost Behavior.


    Why is it important to understand
    Cost Behavior?
    •For future use. 🗓 How a manager plans is based on past
    or current trends. 😁
    •For emergency. 🚨 In case things do not go well as
    planned, you know what to tweak, based on your
    understanding of cost behavior, just because it is under
    your control. 😉
    •For analysis. 🧠 Cost Analysis is an integral part of the
    above-mentioned functions, planning and control. To
    predict accurately, you must understand how costs behave.
    How do Costs Behave?
    The assumed range of
    activity that reflects the
    company’s normal
    operating range is
    referred to as the
    relevant range.

    Types of Cost Behavior Patterns:


    Variable Costs
    • Changes proportionately and directly in response to the
    level of activity.
    Level of activity (x) Total costs (y) Per-unit cost (y÷x)
    1 5 5
    2 10 5
    3 15 5
    4 20 5
    5 25 5

    • In total, it depends on the direction of the activity level.


    • Per-unit costs are constant.
    Fixed Costs
    •Does not change regardless of level of activity.
    Level of activity (x) Total costs (y) Per-unit cost (y÷x)
    1 60 60
    2 60 30
    3 60 20
    4 60 15
    5 60 12

    •In total, it does not change.


    •Per-unit costs decrease as level of activity increases.
    (Inverse relationship between fixed cost and activity
    level)
    Examples
    Variable cost Fixed cost
    •Direct material •Rent
    •Direct labor •Insurance
    •Some overhead costs •Taxes
    • Materials handling •Salaries of
    • Utilities supervisors
    • Supplies
    •Straight-line
    •Some selling costs depreciation
    • Sales commission
    • Distribution
    •Advertising
    Mixed Costs
    •Also called semi-variable costs (Part-fixed, part-variable)
    Level of activity (x) Total costs (y) Per-unit cost (y÷x)
    1 150 150
    2 180 90
    3 210 70
    4 240 60
    5 270 54

    •In total, it is like variable cost, in the sense that total


    costs increase as activity level increases.
    •As to per-unit cost, it is like fixed cost, in the sense that
    per-unit cost decreases as activity level increases.
    Analysis and Example of Mixed Costs
    •Fixed component: represents the
    minimum cost of having a service
    ready and available for use
    •Variable component: represents the
    cost incurred for actual consumption
    Example:
    ☎️Internet subscribers incur costs that are mixed: The fixed
    component represents the cost of being connected. 🖇 The
    variable component represents the amount of data consumed
    or time lapsed. 🕒
    Separation of Mixed Costs
    Importance: to make separate analyses on the fixed and
    variable components; separate decisions could be made
    on those components.

    Methods to be used in ACCT 1033: 🔧🔨


    • High-low method ⬆️ ⬇️
    • Least-squares regression method 📊
    The Cost Formula
    Before proceeding to the methods of separating mixed
    costs, we need to be acquainted with the cost formula:
    y = a + bx
    where note: the cost formula is
    y: total costs derived from the
    a: fixed costs slope-intercept
    b: variable cost per activity level formula in linear
    x: activity level algebra
    High-Low Method ⬆️ ⬇️
    •Uses two points, representing two situations (activity
    levels and corresponding costs) in predicting the
    relationship between costs and activity level
    Formulae:
    b = (Cost at highest activity – Cost at lowest activity)
    Highest activity – Lowest activity
    a = y – bx (highest) or
    a = y – bx (lowest)
    High-Low Method ⬆️ ⬇️
    Level of activity (x) Total costs (y) Per-unit cost (y÷x)
    1 150 150
    2 180 90
    3 210 70
    4 240 60
    5 270 54

    b = (270–150) ÷ (5-1) = 120/4 = 30


    a = 270 – (30)(5) = 270-150 = 120
    a = 150 – (30)(1) = 150-30 = 120
    Fixed component: 120
    Cost function: y = 120 + 30x Variable component: 30 per activity
    Least-squares regression method 📊
    Statistical technique which determines a line of
    regression by solving a systems of linear equations which
    are based on the condition that the sum of deviations
    above the regression line equals the sum of deviations
    below it.
    Equations:
    Σy = na + bΣx
    Σxy = Σxa + bΣx2
    Least-squares regression method 📊
    Equations: Level of activity (x)
    1
    Total costs (y)
    150
    Per-unit cost (y÷x)
    150

    Σy = na + bΣx 2 180 90
    3 210 70
    Σxy = Σxa + bΣx2 4 240 60
    5 270 54

    x
    1
    y
    150
    xy
    150
    x2
    1
    We will need to expand the table
    2 180 360 4 above 👆🏻 in order to obtain the
    3 210 630 9 necessary variables needed in
    4
    5
    240
    270
    960
    1,350
    16
    25
    both equations.
    Σx = 15 Σy = 1,050 Σxy = 3,450 Σx2 = 55 👈🏻 Here is the expanded table.
    Least-squares regression method 📊
    x y xy x2

    Equations: 1
    2
    150
    180
    150
    360
    1
    4
    Σy = na + bΣx 3 210 630 9
    4 240 960 16
    Σxy = Σxa + bΣx2 5 270 1,350 25
    Σx = 15 Σy = 1,050 Σxy = 3,450 Σx2 = 55

    Substituting the variables into the equations, we get two


    equations:
    (1) 1,050 = 5a + 15b
    (2) 3,450 = 15a + 55b
    Least-squares regression method 📊
    In order to solve this system of equations, we need to
    multiply 3 to equation (1), to easily eliminate the variable a.
    (1) 1,050 = 5a + 15b ➡️ 3,150 = 15a + 45b
    (2) 3,450 = 15a + 55b ➡️ 3,450 = 15a + 55b
    Eliminating a and subtracting (2) from (1) , we get:
    300 = 10b

    Dividing both sides by 10, we get: b = 30


    Least-squares regression method 📊
    We can solve for a by substituting b into any of (1) or (2).
    (1) 1,050 = 5a + 15b (2) 3,450 = 15a + 55b
    1,050 = 5a + 15(30) 3,450 = 15a + 55(30)
    1,050 = 5a + 450 3,450 = 15a + 1,650
    5a = 600 15a = 1,800
    a = 120 a = 120
    Therefore, we have the cost formula y = 120 + 30x, same
    cost formula we obtained using the high-low method ⬆️ ⬇️.
    Other methods to separate mixed cost
    •Scattergraph method
    • Like Least-squares, it also aims to draw a line (called the
    “regression line” or “line of best fit”) such that the distances of
    the points above and below the line are equal. The only
    difference is that Least-square is mathematical, Scattergraph
    is visual.
    •Account Analysis method
    • based on experience and judgment of managers and
    accountants familiar with the company’s operations.
    Other methods to separate mixed cost
    •Industrial Engineering method
    • Estimates the cost function by analyzing the relationship
    between inputs and outputs.
    • Steps:
    • A study of the physical relation between inputs and units of output
    is made by
    • making a detailed step-by-step analysis of each phase of
    manufacturing is done.
    • estimates of materials required for each unit to be produced are
    obtained from specification sheets.
    • Costs are assigned to each physical input
    Correlation analysis
    Correlation: measure of the co-variation between the
    dependent (cost) and independent (level of activity)
    variables.

    Coefficient of correlation (r): measure of the extent of the


    linear relationship between the two variables.

    Note: values of r can only be from -1 to 1.


    Correlation analysis
    Additional notes:
    •If r = 0, there is no correlation
    •If r is positive, there is a direct relationship between x and y
    (If x increases, y increases). The regression line slopes
    upward to the right.
    •If r is negative, there is an inverse relationship between x
    and y (If x increases, y decreases). The regression line
    slopes downward to the right.
    •If r is 1 or -1, there is perfect correlation.
    Correlation analysis
    Coefficient of Determination (r2): represents the percentage
    of the total variation in the dependent variable (y) that is
    explained or accounted for by the regression equation.

    A very high r2 means that the values in the regression


    equation explain virtually the entire amount of the total cost.
    The variables are highly correlated, i.e. the cost driver (x)
    selected is highly related to the dependent cost (y).
    Correlation analysis
    Standard Error of the Estimate: standard deviation about the
    regression line; serves as a confidence interval or
    acceptable range of tolerance, for use in exercising control
    over the costs. A small standard error indicates a good fit.
    Zero standard error is the best fit. Formula: std error = 1-r2

    Prediction errors/Errors of estimates: difference between


    the estimated values computed using the regression
    equation and actual values.

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